What is selection bias in finance studies?

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AcadiFi · Accepted Answer

Selection bias occurs when the sample used for analysis isn't representative of the population you're drawing conclusions about. It's different from survivorship bias (which drops dead units) — selection bias affects how units entered the sample. Private equity is a textbook case: (1) funds self-report returns to databases voluntarily; (2) poorly performing funds often stop reporting; (3) new funds report back-filled returns only if they're good (backfill bias); (4) PE funds mark illiquid holdings subjectively, smoothing volatility. Example: Cambridge Vista Analytics studies 400 PE funds from 2005-2020 using a commercial database and finds 14.2% IRR. Correcting for reporting selection, backfill bias, and NAV smoothing reduces the figure to ~10.5% — still good but less dramatic. Other examples: (1) studies of IPO returns using only completed IPOs omit withdrawn deals; (2) venture capital studies exclude failed startups whose data was never collected; (3) executive compensation studies using proxy-filing firms omit private firms. Fix: use comprehensive data sources where possible, test for non-random missingness, and apply Heckman two-stage correction when inclusion depends on observables.

What is selection bias in finance studies?

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